12th Annual Southeast Mortgagee Advisory Council
(SMAC) Conference
Hilton Head Marriott Resort and Spa, Hilton Head, SC
May 29 – 31, 2013
Combining Tax Exempt, Short-Term Bonds with Taxable GNMA
Sale for Affordable Apartment Financings
Presented by:
R. WADE NORRIS, ESQ.
JOHN RUCKER
wnorris@ennbonds.com
john.rucker@merchantcapital.com
(202) 973-0100
EICHNER NORRIS & NEUMANN PLLC
1225 19th Street, N.W., 7th Floor
Washington, D.C. 20036
website: www.ennbonds.com
(334) 834-5100
MERCHANT CAPITAL L.L.C.
2660 EastChase Lane
Montgomery, AL 36117
The Bright Road Ahead For U.S. Multi-family Rental Housing
Historic and Projected Multifamily Housing Starts (Thousands)
(For Rent) 2000-2016
400
(0)
(15)
(50)
(40)
(20)
(140)
(130)
(60)
(0)
2004
2005
2006
2007
2008
2009
2010
2011
2012*
+50
+90
+120
+120
350
300
250
200
150
100
50
0
2000
2001
2002
2003
*2012 Estimated Data from Harvard Study; High number Zelman & Associates per Wallstreet Journal 10-03-12, p. A6
**Estimated per Zelman & Associates above.
***Estimated 2015 and 2016 units needed to almost replace cumulative deficit during
2009-2012 in 2000-2008 yearly average of 230,00 units per year
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2013** 2014** 2015*** 2016***
2009 - 2011 Cumulative Deficit
v. 230,00 per yr. (2000 - 2008 average)
= 330,000 units
Merchant Capital L.L.C.
2016 +380,000 Cumulative
above 230,000 av. (00 - 08)
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
From 2000 – 2008, the United States has produced about 230,000
units of new multifamily rental housing per year. If one estimates
rehabilitated units at 50,000 – 150,000*, perhaps total production of
300,000 to 400,000 units per year

Volume fell precipitously post 2008 – 90,000 new units in 2009;
100,000 in 2010; 180,000 in 2011 from 230,000/ year average

Cumulative deficit in new rental units 2009 – 2011 of 330,000 units
– a major current driver of new rental unit demand
________________________________
* Housing for All Americans 2007-2008, Affordable Housing Finance Magazine, citing NCSHA data
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ADDITIONAL HUGE DRIVERS OF MULTIFAMILY
RENTAL HOUSING DEMAND

Post WWII Baby Boom “Echo” generation entering with force and
seeking housing

Continued Net Immigration (immigrants rent for 10 years before
buying)

Severe tightening in lending standards for single-family home
loans post 2008 – U.S. home ownership 69%  65%
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ABOUT ONE THIRD OF ABOVE IS AFFORDABLE
RENTAL HOUSING (60% AMI OR LESS)
Two Major Programs of Above – Both Involve Low Income Housing Tax
Credits (“LIHTC”):
1.
2.
9% LIHTC - about 70,000 units/ year at peak
4% LIHTC combined with Low Rate Tax Exempt Bonds – about
60,000 units/ year at peak
Year
2004
2005
2006
9% LIHTC
Tax-Exempt Bond Plus 4%
LIHTC
76,326 units
63,674 units
(No breakdown given)
71,171 units
60,433 units
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Total
140,000 units
132,449 units
131,704 units
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LOW INCOME HOUSING TAX CREDITS (“LIHTC”)
What is a “tax credit?”
A tax credit entitles the holder to offset the check he or she
would otherwise have to write the federal (or state)
government for income taxes owed in a given year dollar-fordollar, up to the amount of the tax credits he or she holds.
Better than a tax deduction, which is worth only 30 or 40¢
per dollar, since deductions only lower your income. If you
are in a 35% tax bracket, a $1.00 deduction is worth 35¢; it
saves you 35¢ in taxes you would otherwise pay. A dollar of
tax credits is worth a dollar because it directly offsets a
dollar of taxes you owe and would otherwise have to pay.
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How Does Low Income Housing Tax Credit Equity work?
 Section 42 of IRC permits investors in qualified projects
to claim an annual credit against federal income tax for
a 10-year period after the project is placed in service
 Amount of credit which can be taken each year is a
specified percentage (e.g., approximately 9% or
approximately 4%) of the “qualified basis” of the
affordable units
 “Qualified Basis” is roughly speaking, total
development cost less land and commercial
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9% LIHTC PROGRAM
 Can sell 9% tax credits for about 65% of Total Development
Cost
 Very popular program, but very little volume versus demand
 Results in small loan size; unattractive for FHA execution
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TAX EXEMPT BONDS PLUS 4% LIHTC PROGRAM
 Must obtain private activity bond volume allocation, but much easier to get
than 4% LIHTC allocation
 Can sell 4% tax credits for about 25% - 30% of Total Development Cost:
TAX EXEMPT BOND +4% LIHTC PROGRAM
Assume: Total Development Cost
Less: Land
Less: Commercial
Qualified Basis
Assume: Difficult to Develop Area/ (“DDA”) or Qualified
Census Tract (“QCT”)
Assume: 100% Affordable
Eligible Basis:
Tax credit rate (not really 4%)
Annual credit amount
Ten years of credits
Assume: 85¢/$1.00 pricing
Net 4% LIHTC Syndication Proceeds to Borrower
$25.0 Million
(3.5 Million)
(1.5 Million)
$20.0 Million
X 1.3
$26.0 Million
X 1.0
$26.0 Million
X 0.035
$910,000
X 10
$9.1 Million
$7,735,000 (31.0%)
 While loan size a bit smaller than for market rate project, still quite
substantial
 Increasingly important part of US Housing stock – perhaps one of every
six apartments or more
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SINCE 2008 – UNIQUE OPPORTUNITY TO FINANCE
AFFORDABLE HOUSING BY COMBINING TAX
EXEMPT BONDS + 4% LIHTC WITH FHA INSURANCE
OR GSE CREDIT
Results from fact that since financial crisis in 2008, U.S.
Government backed debt has traded at yields dramatically
lower than all other long-term debt instruments, including
even tax exempt municipal bonds.
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SINCE 2008 – EXTREMELY LOW RATES ON U.S. TREASURY BACKED DEBT ISSUES
30-Year MMD (Tax Exempt)
Versus 10-Year Constant Maturity Treasury (Taxable)
30-Year MMD
7.50%
10-Year CMT
Early 2008 – Taxable US Government Securities
Rates Fall Below Tax Exempt Municipal Rates
6.50%
~400
bps
5.50%
4.50%
3.50%
~127
bps
2.50%
1.50%
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COMBINING LONG TERM TAXABLE LOANS WITH
SHORT-TERM TAX-EXEMPT BONDS AND 4% LIHTC
•
Since 2008 taxable FHA/GNMAs Market, have delivered extremely low rate pricing:
– FHA/GNMA: 223(f)/221(d) GNMA sales currently provide 3.5% - 4.0% all-in borrowing rate
with no negative arbitrage and 35-40 year amortizations.
– Fannie/Freddie loans with no “construction” period (i.e. immediately funded transactions w/
mod-light rehab) currently provide 4.0% - 4.5% all in borrowing rate with 30-35 year
amortizations.
VS
•
Traditional Long-Term Tax Exempt Bond Financing:
– 18 - 40 Year Bond Coupon is 3.50% or higher.
– After 3rd party fees and overides are added, all-in borrowing rates are 5.0% or higher.
– New Construction/Sub Rehab Bond Financings also require a significant amount of
Negative Arbitrage (~5 - 10% of Loan Amount)
 Advantages of Taxable Executions:
– ~0.50 - 1.50% lower permanent borrowing rate: resulting in additional loan proceeds on a
debt service constrained loan and/or increased ongoing project cashflow.
– New Construction/Sub Rehab deals: dramatic reduction in negative arbitrage deposits
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4% LIHTC 50% TEST
With today’s low taxable loan rates, why not just borrow
funds in the taxable market?
Reason: Under Section 42, in order to qualify for the full
value of the 4% Low Income Housing Tax Credits, at least
50% of aggregate basis of the building and land must be
financed from tax exempt bond proceeds.
However, these tax exempt bonds only need to remain
outstanding until the Project’s “placed-in-service” date.
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LONG TERM TAX EXEMPT BONDS
Traditional Long Term Tax Exempt Bond Execution:
1
18-40 Year Bonds
Bond
Purchaser
Trustee
2
Bond Proceeds
6
MBS
5
Bond Proceeds
Draw Request
3
Borrower
FHA/GSE Lender
4
Loan Funding
Problem: High Mortgage Rate (and large Negative Arbitrage deposit for New
Construction or Substantial Rehab transaction)
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COMBINED TAXABLE LOAN WITH TAX EXEMPT BONDS
8
Bond Payoff
~2-Yr Bonds
(after Project is placed
in service)
Trustee
1
6
2
Bond
Purchaser
Bond
Proceeds
Bond
Proceeds
Account
Escrow
Account
MBS
Proceeds
MBS Purchaser
7
Bond Proceeds
5
3
Sale of
Taxable MBS
Draw Request
Borrower
FHA/GSE Lender
4
Loan Funding
Benefits: Qualifies for 4% LIHTC; Low Mortgage Rate (and minimal negative arbitrage
deposit for new construction or substantial rehab transaction)
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EXAMPLE COMPARISON FOR FHA/GNMA TRANSACTION
Traditional Long-Term
Tax-Exempt GNMA
Backed Bonds
Short-Term CashCollateralized Bonds with
Taxable GNMA Sale
FHA Loan Amount:
$8,000,000
$9,000,000
FHA Loan Term/Tax-Exempt Bond Term:
35/35 Years
35/2 Years
Mortgage Loan Interest Rate
Bonds
4.25%
GNMA
3.25%
3rd Party Fees
0.15%
3rd Party Fees
Servicing +
GNMA Fee
0.25%
Servicing +
GNMA Fee
0.25%
Total ML Rate
4.65%
Total ML Rate
3.50%
N/A
Result  1.65% ML Rate Savings (~12% additional loan proceeds on debt service constrained loan)
Estimated Negative Arbitrage Savings for New Construction / Substantial Rehabilitation Transactions:
4.65% x 8,000,000 x 2 years
0.75% x $7,000,000(1) x 2 years
$744,000 (9.30% of ML)
$105,000 (1.17% of ML)
$372,000 (4.65% of ML)
$52,500 (0.58% of ML)
Negative Arbitrage (Deposit):
Negative Arbitrage (Actual):
(1) $7 million sized on 50% test ($13 million total costs)
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EXAMPLE SOURCES AND USES
Traditional Long-Term Tax-Exempt GNMA
Backed Bonds
Sources
Short-Term Cash-Collateralized Bonds with
Taxable GNMA Sale
Sources
FHA Loan Funds
Bond Proceeds/FHA Loan
$8.0 M
$9.0 M
(1)(1)
Bond
Proceeds
Bond Proceeds
7.0 M
4% Tax Credit Equity
3.5 M
4% Tax Credit Equity
3.5 M
Deferred Developer Fee
0.5 M
Deferred Developer Fee
0.0 M
Subordinate Financing
1.0 M
Subordinate Financing
0.5 M
Total Sources
$13.0 M
Uses
Total Sources
$20.0 M
Uses
Redemption
Bonds
Redemption ofofBonds
Acquisition
$8.0 M
$7.0 M
Acquisition
8.0 M
Rehabilitation
3.0 M
Rehabilitation
3.0 M
Developer Fee
1.0 M
Developer Fee
1.0 M
Financing Costs + Soft Costs +
Reserves
1.0 M
Financing Costs + Soft Costs +
Reserves
1.0 M
Total Uses
$13.0 M
Total Uses
$20.0 M
(1) $7 million sized on 50% test ($13 million total costs)
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TWO SAMPLE TRANSACTIONS
223(f) Pilot Program Acq./ Rehab Deal
Expected Placed-In Service Date/ Bond First
Optional Redemption Date
9 Months
Stated Bond Maturity
18 Months
Estimated Rate¹
18-Month MMD or
LIBOR + Spread = 0.80% (or lower)
Interest Deposit at Closing
18/12 x 0.80% = 1.20% of Bonds
Expected Actual Bond Interest Cost
9/12 x 0.80% = 0.60% of Bonds
¹
Actual rates MAY VARY GREATLY based on deal size, project location, type of loan, market conditions and
many other factors.
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TWO SAMPLE TRANSACTIONS
221(d)(4) New Construction
Expected Placed-In Service Date
20 Months
Stated Bond Maturity
36 Months
Initial Mandatory Tender Date/ First
Optional Call Date²
13 Months
Initial Interest Rate
0.5% (or lower)
Upfront Interest Deposit
Negotiable, but at least:
13/12 x 0.5% = 0.542%³
Expected Total Interest Cost
(if rates don’t change)
20/12 x 0.5% = 0.833% of Bonds
² Makes Paper Tax-Exempt Money Market Fund Eligible; dramatically lowers coupon.
Borrower and 4% LIHTC
investor must get comfortable with remarketing risk; but risk very low.
³ Additional deposit of capitalized interest in bankruptcy remote funds required if Bonds not called on 1st optional
call date.
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RESULTS OF STRUCTURE
Net Results – Borrower:
•
50 - 150 basis points of savings in permanent borrowing rate, resulting in a lower
cost of capital over the life of the loan
–
Increased Loan Proceeds and/ or
–
Increased Cash Flow
•
Full syndication value of 4% LIHTC equity on affordable units achieved
•
For New Construction or Substantial Rehab Transactions, Negative Arbitrage deposit
is significantly reduced
Net Results – IRS:
•
Often results in fewer Tax Exempt Bond proceeds needed to fund Qualified
Project Costs – $1.0 million less in example compared to the traditional long-term
tax exempt bond issue
•
No arbitrage “artifice or device” - all Tax Exempt Bond Proceeds (and replacement
proceeds) invested at far below tax exempt bond yield
•
No “over issuance” of bonds or “overburdening” of market – only Tax Exempt
Bonds to meet 50% test, and outstanding 2 years versus 18+ years
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Other Related Questions/Issues
Bond Amount > Taxable Loan Amount:
•
Other sources of funds (i.e. Equity, Subordinate loan, etc.) needed to cover the
differential. Timing of funding is crucial
•
Additional Rating Agency requirements on publically offered transactions
Bridging Equity:
•
Limited collateral available for bridge financing
Publically Offered vs. Privately Placed:
•
Timing; Cost; Issuer requirements
Bond Interest &Third Party (Bond Related) Fees
•
Typically escrowed at closing with Trustee for full term of Bonds
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CONCLUSION
•
All major bond counsel firms with whom we have worked have issued
or agreed to issue unqualified approving opinions on deals using this
type of cash collateralized structure for numerous tax exempt multi-family
housing bond issues
•
Documents and rating agency criteria are well developed
•
This structure has become a THE WAY to finance affordable housing
projects with FHA insurance and also works with other GSE executions
•
Unlikely that market conditions will change in next 12-18 months to
favor traditional long-term tax exempt bond structure
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